Inheriting a house is a gift, from someone we care about. It also starts a process that can be overwhelming with emotions. It’s natural to feel a mix of emotions when receiving property due, to the passing of a loved one. The financial decisions that come with inheriting property can be stressful and confusing.
To navigate this situation effectively it’s important to understand your options consider the implications of each choice and seek professional advice to navigate any tax or legal requirements.
Tax considerations; Do I need to pay taxes on a property?
When you find out that you’ve inherited a house one question that often arises is whether you need to pay inheritance tax on the property. Inheriting the property itself does not automatically create any tax obligations. However how you choose to handle the house—whether you decide to live in it rent it out or sell it can lead to property taxes capital gains taxes or other expenses ( details.
What are capital gains taxes?
Capital gains taxes refer to the taxes owed to the government based on any profits made from selling an investment.
For instance when it comes to capital gains taxes you’ll need to consider the difference, between the purchase price of a property and its selling price. However keep in mind that capital gains taxes are usually not applicable when selling your residence long as you’ve lived in it for at least two years within the past five years.
In case you do have to pay capital gains taxes the rate will be based on your income. Nevertheless if you inherit a home there’s usually protection against most of the capital gains taxes thanks to what’s known as the step up tax basis.
So what exactly are step up taxes or the step up tax basis? As someone who inherits a property you benefit from a step up tax basis which means that you inherit the home at its market value on the date of inheritance. Consequently you will only be taxed on any gains made from the time of inheritance until when you decide to sell it.
To provide an example;
imagine that your grandmothers house was originally purchased back, in 1960 for $25,000. Now lets say that its current value is $425,000. Does this mean that if you sell the house your taxable profit would be $400,000? Fortunately not.
You will only have to pay taxes on any gains you make, between the time you inherit the property. When you sell it.
I recently inherited a property. What should I do next?
What you choose to do with your inherited property depends on its status, physical condition and any time limitations.
Is there an existing mortgage on the property?
If there is a mortgage on the property you inherited the specific details of that mortgage could impact your decision making process regarding whether to sell or rent the property promptly.
- Due on sale clause; Check if the mortgage contains a, on sale clause, which means that if you transfer ownership of the property to someone particularly a non family member then the entire loan becomes due and payable. This clause might require you to either pay off the mortgage or sell the property. In cases where family members inherit a property they can often simply take over making mortgage payments.
- Mortgage; A reverse mortgage is a product commonly utilized by older homeowners who want to access their homes equity without having to move. In this arrangement the original owner receives cash based on their homes equity. Repays the loan upon vacating.
After the original owner passes away the recipient usually has a period of time six months to repay the outstanding amount. There are an options you can use your own funds to settle the remaining balance sell the inherited property to cover the loan amount or obtain a new loan in your name to fulfill the financial obligation.
In cases where the propertys value’s lower, than what’s owed on it (known as being “underwater”) you may be able to negotiate with the issuing bank for a short sale. This means selling the property for an amount than what’s owed on it.
Here are some options to consider;
- Buyout; If one sibling wishes to keep the home while the other wants to sell an arrangement can be made where one sibling buys out the others share. This can be done through cash payment or by financing half of the homes value. Expenses involved would include closing costs and an appraisal.
- Promissory note; If you intend to retain ownership of the property but your sibling wants to sell and you don’t have access to a mortgage you can establish a note. This note will outline how you will gradually repay your sibling for your share of the homes value through installments with interest. Essentially you will be buying out your sibling, over time while they receive interest income along the way.
Here are an options to consider regarding the inherited property;
1. Sell and divide the profits; The straightforward choice would be, for you and your sibling to sell the home. After deducting expenses and commissions you can each keep your share of the proceeds.
2. Rent and divide the profits; If the real estate market is not particularly strong you might find it more financially beneficial to rent out the property. In this scenario you and your sibling would split whatever profit remains after covering maintenance and property management costs.
3. Seek action for partition; If all parties involved cannot come to an agreement on what to do with the property you may have to resort to filing a lawsuit for partition. Essentially this means asking a judge to order the sale of the home. However it’s important to note that this process can be time consuming and costly due, to fees potentially reducing your profits compared to selling initially.
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